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Chapter 6: DISCIPLINE

The next level of the pyramid is discipline. It is said, and it is true, that without discipline you will be unable to make any progress. The reason is simple and comes in a number of guises. First, without discipline you will be unable to follow your own methodology, you will, in effect, have no methodology. Thus you will be doomed to trade emotionally, and that is not a winning approach. Second, you will not have the self discipline to overcome your own emotions and instincts. So in some ways these two factors overlap, but the second is far more pervasive than simply in operating your methodology.

The big question here is whether you can develop the discipline if you do not have it naturally. I believe that the answer is “yes, you can,” but you must have the necessary commitment to do so.

Clearly discipline can be developed, and you only need to look at an army training program for confirmation of this fact. But it is one thing to have a vast and experienced organization bearing down on you and prepared to do whatever it takes to make its point, quite another to do it yourself in the comfort of your own home, with all the distractions that normally involves. Clearly self discipline is going to be a requirement even to start the process.

However, the market itself is going to be helpful, although not as helpful as it might be. Ultimately undisciplined behavior is going to be punished by the market, either by direct losses or by the loss of profits which would otherwise have been available. So private traders who persevere do have external stimuli that help the process. But the market does not help as much as it might because of the principle of random reinforcement. I will mention this again. It is the market’s tendency to reward bad behavior from time to time. What works one day may not work the next and this applies to the “best” trading practice. Similarly bad habits do bring rewards from time to time. This crucial fact is one of the reasons that it takes so long to learn how to trade.

Discipline and the Trading Pyramid

So, let us look at discipline within the context of the Trading Pyramid. We have already discussed how the various levels of the pyramid interact. Now I want to concentrate on how this interaction relates to discipline. There is a great deal of difference between applying discipline to doing something you like, as opposed to something you don’t like. For example if you like playing a particular sport, say tennis, then you may find it very easy to be disciplined when taking shots, keeping score, following court etiquette, and the rest. No problem, because you would enjoy the whole thing. But say you had to go fishing and you couldn’t stand it. Would you have the same discipline with baiting the hook, casting the line, sitting patiently waiting for a bite, etc.? No, you wouldn’t. You would probably be slapdash and sloppy, you would probably fidget, when you need to be still. It is the same with trading. If you find an approach that suits you, it will be much easier to follow. You will avoid trying to squeeze a square peg (yourself) into a round hole (your market approach). This applies to every level of the pyramid. Your Money Management (MM) system is designed to keep you safe so that you can relax. Much easier to apply discipline in such an environment. Risk Control has a similar function. It is all about making you comfortable and developing the skills to keep your losses under control. Again this makes the trader’s situation a lot more comfortable. Moving up to the next level we come to the three simple rules. The logic of these rules is unassailable. However, we have to learn how to use them and this takes time, especially learning to let profits run. After all the skills needed to cut losses are almost exactly the opposite of those required to let profits run. The first requires careful monitoring and quick action (maybe using a stop in the market to do it for you) whereas the latter requires a more relaxed approach to avoid getting out. So one is actively looking to get out, the other is passively not looking to get out. Once you have learnt actively to look to get out, how do you then totally adjust your view to achieve the other? It takes time.

It is easy to see how we can be a lot more relaxed, and therefore more disciplined once we have learnt how to operate these rules. Some readers may feel that linking the words “relaxed” and “disciplined” is something of an oxymoron, or two incompatible concepts. I disagree. In my view relaxation is the essence of “easy” discipline. You do not need to be tense and standing to attention to be disciplined. You just need to be able to do certain things in a certain way. The easier these things are, because you choose what they are, the more experience you have in doing them, clearly the easier they will be to do.

System parameters

This brings us to your system parameters. It is going to take time to discover these. This is not because there is any particular magic about the parameters themselves, but because you need to know yourself well before you will be able to judge what is going to suit you. There is a feedback loop involved in this process. Once you start to use a more precise methodology that feedback loop can start. Until that point most traders are just spinning their wheels. Once you start to use a methodology you begin to learn a lot about yourself. This is because you start to see when you have difficulties with the methodology. You are forced to stop and ask yourself. “Why did I not take that trade?” and, perhaps more importantly, “Why did I take this trade which has nothing to do with my methodology?” Often you find that you have certain preconceptions which are not useful, that you have impulses to trade that have nothing to do with making money, but have everything to do with various emotions you have not yet learnt to control. At least that was my experience.

It is the feedback from these things you learn about yourself that allows you to modify your methodology. This process, which takes you round the loop many times, eventually allows you to discover something that is truly useful to you. It will not necessarily be useful to anyone else. This is why I am always distrustful of those who claim to have market “secrets” they will not disclose. To my mind this shows a misunderstanding of the entire process, although I can see why someone would not want to disclose their entire methodology. The more people who trade “your way” the less likely that way is to be effective. But even this is debatable as any trader who looks at another’s methodology is liable to alter it and trade it in their own way. However there is no point in taking any chances in this respect, why take the risk?

SUMMARY

 Discipline is necessary because without it you will not be able to follow your methodology, or to control your emotions and instincts.

 Developing discipline is a process rather like exercising muscles, but is helped by developing an approach that suits us.

 Random reinforcement is the way in which the market often rewards “bad” behaviour and punishes “good behaviour”. Rats go mad when treated like this.

 Inter-reactions between discipline and other levels of the Pyramid show the importance of developing all levels of the Pyramid in line with our personalities.